British Pound Under Renewed Pressure as Hard Brexit Looms

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The British pound’s losses deepened in October on worries that a “hard Brexit” would restrict banks’ access to the single market, leading to speculation that major financial institutions may relocate out of London.

Bankers’ “hands are quivering over the relocate button,” wrote Anthony Browne, CEO of the British Bankers’ Association,[1] in response to Prime Minister Theresa May’s call for a hard exit from the European Union.

As one of the world’s major financial centres, London would be devastated by a mass exodus of banks over Brexit fears. Financial institutions pay more than £60 billion in taxes each year, making them a huge source of revenue for the British economy.

Concerns about an exodus of banks have weighed on the British pound, which has declined a staggering 18% against the US dollar since the June 23 Brexit vote. The Bank of England (BOE) is already preparing for the blowback, having eased monetary policy in August for the first time since the financial crisis.

The GBP/USD exchange rate referenced by the global currency system ended the month of October in the low 1.22 region. It was trading above 1.55 at the same time last year. A flash crash in early October sent the pound to its lowest level in 168 years.[2]

The BOE has warned that a plunging local currency may result in higher inflation, something policymakers will be forced to stomach as they prioritize economic growth over short-term price stability. According to central bank governor Mark Carney, the BOE is willing to overshoot the 2% inflation target over the short term.

BOE policymaker Kristin Forbes said the overshoot could be “sharp” due to the stimulus measures announced in August.

“All in all, partly due to this package, partly due to the underlying momentum in the economy, partly due to other changes in the economy, it does look like the days of inflation bouncing around zero are long gone,” Forbes said at a conference organized by the Polish central bank in October.

“Inflation is already picking up. It will pick up even faster and we are likely to overshoot our 2% inflation target perhaps sharply in the next two years,” she told a conference organised by Poland’s central bank.[3]

The UK’s annual inflation rate rose 1% in September, up from 0.6% in August, the Office for National Statistics (ONS) reported last month. That was the fastest rate of inflation in almost two years. Clothing prices rose at the fastest amount since 2010, while fuel was also more expensive. At this point, the ONS said there was “no explicit evidence” that the rise was due to a weaker pound.[4]

Hedge funds have reduced their bets that the British currency will fall, according to recent data provided by the Commodity Futures Trading Commission. However, at 97,582 contracts in the first week of October, net short positions remain close to an all-time low.[5]

For all the woes surrounding the pound, there’s little evidence that Brexit is weighing on the British economy – at least, not yet. Gross domestic product (GDP) expanded 0.5% in the third quarter, beating estimates calling for 0.3%, the ONS reported last week. Compared to a year ago, GDP expanded 2.3%. GDP expanded 0.7% in the second quarter.

The latest selloff in the pound was triggered in early October by British Prime Minister Theresa May, who said she would begin pursuing a hard exit from the EU by the end of March. That’s when the UK government is expected to trigger Article 50, the EU mechanism that officially kicks off the Brexit process. From that moment, the UK will have two years to secure a new trade deal with Brussels, a small window given the complexity of the negotiation process and Britain’s stance on immigration.

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